Saturday, October 2, 2010

EXUBERANCE is often an indicator of an unsustainable pattern, be it for equities, collectibles or real estate. A rumbustious atmosphere in any asset class, more often than not, eventually leads to a deflation, which can be painful to swallow for its participants.

The two asset classes that have seen their fair share of bubbles are stocks and property, fuelled by euphoric expectations of higher profits and easy credit. The banking sector has always been in the forefront of such situations.

Prior to the 1997/98 financial crisis, banks had lent most of their money to businesses while a lot of cash was also diverted for the purchase of shares.

Then, household debt was much lower as a percentage to gross domestic product (GDP) than it is today and residential loans accounted for about 16% of total loans.

When the economy crumbled during the crisis more than a decade ago, the banks were severely hurt, not just in Malaysia but throughout much of South-East Asia and other countries that saw their currencies attacked and a spooky flight of capital.

Many banks in Malaysia had to be recapitalised and that was the catalyst to the consolidation of the banking sector that today, has resulted in the creation of nine anchor banks in the country.

Learning from the causes of troubles back then, companies shifted their funding needs to the debt capital market, which defrayed the risks and funding needs of corporations away from banks.

That transition by all accounts has been a success. Malaysia’s debt capital market is one of the most robust in Asia but the migration of corporations meant banks had to look for a new source of business.

Financial institutions then steered their sights to the household sector, which was prime for more credit as debt levels within homes were low as a percentage of GDP.

Household debt demand

As it stands today, household debt has grown by leaps and bounds. As a percentage of GDP, it was 40% in 2000 and that has grown by more than 50% to around 65% today.

Much of the credit demand has come by way of providing financing for the purchase of cars and of late, a surge in giving money to people for consumption needs. But the lions’ share of that funding constitutes home loans, largely owing to low interest rates and a steady rise in income levels.

“Interest rates have fallen and that has attracted people to borrow more,’’ said ECM Libra head of research Bernard Ching.

Housing loans are also seen as a safer bet for banks as traditionally, the non-performing loans for houses are low.

Margins for housing loans are not the best for banks as competition in the segment means that most financing packages out there today charge rates that are below the base lending rate.

Analysts say banks can afford to take a margin hit as funding for such loans, and for all loans in general today, comes from their own deposits where the cost of funds are the lowest.

Banks are awash with cash as, on average, the loans-to-deposit ratio is around 80% for the industry compared with above 100% during the financial crisis.

Also, lending towards the residential sector is a way of diversifying risk. Business loans tend to be lumpy and riskier.

Analysts say for the same amount of money, banks would lend to a single large business and they can carve that out into smaller slices and lend to multiple borrowers in the housing market.

The main difference is the amount banks lend to the value of collateral they get. As property prices in Malaysia tend to rise over time, so would the collateral, usually the home itself.

Financing packages

As interest rates remain low and competition in the housing loan segment has become a cut-throat war for many banks, real estate loan packages have also morphed.

In the past, larger downpayments were needed from homebuyers to purchase houses and the tenures were extended to 25 or 30 years.

Today, reports indicate that some properties, depending on the customer, can be fully funded by a bank loan and the amount of downpayment in general can be as low as 5% or 10%. The tenures are also elongated, up to a borrowers’ age of 60 years.

Also to help households afford homes, the minimum threshold for monthly payments have increased beyond the historical norm of 30% limit.

Analysts say this is possible as long as income rises and interest rates remain low. That risk would, however, compound should the interest rate environment flip in the future.

Mortgage broker Chew Thiam Hock says the low interest rate environment is enticing more people, even those who can afford to pay, to the banks for a higher loan amount.

“In the past, people did not want a high margin of financing but with interest rates so low, they have no problem taking a 90% loan,’’ he says.

The growth of the housing loan industry has also created business opportunities for brokers like Chew who have astute knowledge on the credit appetite of the panel of banks they represent.

Are banks taking too much risk?

With residential loans now accounting for 27% of all loans for banks, the question is are banks are over exposing themselves to housing loans?

Defining a housing bubble is not easy. Prices of property do experience periods of swift rises but the general understanding of a property asset bubble is when the price increase is too rapid devoid of fundamentals.

Some basic indicators include income levels, jobless data, rentals against the cost of a property or even affordability ratios can be used to gauge whether a bubble is forming.

“The risks are essentially the same for the banking sector, whether it’s corporate or housing loans, as consumer loans are a large part of the total banking sector loan,’’ says an economist.

“The ratio was the same in the business sector in 1997/98.’’

But based on the example of Hong Kong market, one analyst disagrees.

Sunil Garg, a banking analyst at JPMorgan Securities, says the housing loan represents one of the safest segments for banks.

“During the Asian financial crisis, losses taken on properties and residential loans were small,’’ he says, adding: “It’s a sector where there is real tangible collateral.’’

With housing loans by banks in Hong Kong accounting for roughly 40% of their loan books, one would think they would have suffered badly when the property market tanked during the 2008 global financial crisis.

However, property prices have since, not only rebounded off their lows, but have scaled new heights, and the loan-to-value ratio in banks means those assets are in a healthier state than before.

Still, the threat of a housing bubble and its far reaching impact can be damaging to any economy. The repercussions are only too well documented world over.

“We need to make sure we do not put our guard down against such risks,’’ says the economist.

Banks becoming more prudent?

One worry surrounding the property market is that building activity tends to ratchet up to take advantage of a boom in prices.

As it stands now, the anecdotal evidence points to a surge in the building of high-end properties. For developers, this segment represents the cream of their business as margins are always the fattest.

According to National Property Information Centre, the ratio of unsold units in the property sector is rising.

While those percentages in Kuala Lumpur and Selangor, where concerns that prices are rising way too fast, are below the national averages, it is nonetheless rising.

With that, analysts say banks are becoming cautious over their lending patterns as internally, they are scrutinising loans with a fine tooth comb.

“Banks might have their own assessment on the value of properties and the intrinsic value, which is the force sale price of a house,’’ says the analyst.

One proposed measure involving the loan-to-value ratio has generated significant debate. Still, it is widely perceived that genuine homebuyers would not be penalised with having to fork out a large downpayment. Those who could be penalised are the third or so on home buyers who will have to come up with 20% or more of the cost of the house.

“It’s a paradox for banks. When loans growth is strong, people will say banks are contributing to speculative activity and the bubble. When they are conservative, people will say banks are not supportive,’’ says a banking analyst.

Social justice

As developers make a beeline to build costlier homes in the hot markets in the country, more people are feeling they cannot afford to buy homes these days.

With workers’ salaries no where close to keeping pace with asset inflation or even the cost of living in the country, the issue of social justice – where every Malaysian should be able to afford a home for themselves – has cropped up.

“There is always a need for affordable housing, so prices remains within the reach of people. You don’t want the banking system to allocate too much money for speculative home-buying purposes,’’ said an economist.

Analysts say banks already have a social obligation to provide a certain amount of financing for the purchase of low-cost housing.

“Banks have a quota. If they don’t meet that, they will be penalised,’’ says an analyst.

As property prices rise, financing packages too tend to evolve alongside. In the past, the minimum downpayment for housing loans used to be much higher than today largely because housing was much more affordable back then.

For banks, the business of home lending has long been viewed as a safe bet. Houses have sound collateral value as they tend to appreciate over time; the downpayments paid for those houses when loans are disbursed act as a buffer for many banks.

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